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The World Cup is in full swing, and on the field remain the final four teams – one of which will lift the golden trophy in just under two weeks. During the 2018 World Cup, BetaShares published a piece focusing on the individual ETFs that an investor could potentially use to form a winning portfolio. While the investment lessons from that time remain relevant to investors today, the following piece will explore some additional lessons that this year’s World Cup can teach us against a backdrop of turbulent, ever-changing markets.
Preparing for the unexpected
Notable stories concerning the football played at this year’s World Cup have, unsurprisingly, focused on the numerous upsets – where renowned footballing nations such as Argentina and Belgium have been humbly thwarted by the likes Saudi Arabia and Morocco. These ‘shock’ upsets have occurred in previous World Cups (think Ireland defeating Italy in 1994 or Cameroon defeating Argentina in 1990), but not with as much frequency as the 2022 competition.
In investing, the possibility or risk of suffering large negative returns due to shock events is referred to as ‘tail risk’. Events like the GFC, Black Monday, the COVID crash, and the stock market decline driven by Russia’s invasion of Ukraine all fit into this category. Looking ahead into 2023, risk is prevalent – with core inflation remaining elevated and global central bank monetary policy further straining economic activity. Market analysts are also noting that equity1 and commodity prices are expected to fall further as slowing global growth dampens demand2.
Yet, as we sit here – hoping for the end of the rate hike campaign, but not yet necessarily focusing on the potential negative economic consequences of this recent central bank action3 – the question remains: how do investors prepare for more market shocks? The principle that should underline an investment strategy to assist in preparing for market shocks is diversification, while also remaining flexible enough to adapt to changing conditions.
Much like the interconnectedness of a successful football team’s defence, midfield, and attack, having a portfolio that is constructed from a variety of asset classes (such as Australian and international equities, fixed income, cash, and property) to balance exposure, seek to enhance performance, and minimise risk in one’s portfolio is crucial. In simple terms, diversification is about not putting all your eggs in one basket.
Adapting to changing conditions
Portugal has shown in this World Cup that it has the flexibility and depth to adapt to new challenges. This was shown recently with the tactical benching of star player Cristiano Ronaldo, whose absence was not felt as the team comprehensively beat Switzerland 6-1. Further, following its frustration with the USA, England altered its formation and changed its Starting XI twice to achieve positive results in matches against Wales and Senegal. Similarly, with changing market conditions and greater market unpredictability, investors will also have to be flexible in the year ahead.
The variety of investment options offered by ETFs not only allow portfolios to be diversified (and to be built simply), but they also offer a high degree of flexibility – whether this be through investors adding thematic exposures or tweaking their traditional holdings to better suit changing conditions.
Fortifying your defence…and emotions
One team that may be overlooked in this World Cup (post its finish) is Morocco. Yet, as at the end of the quarter finals, the team has conceded fewer goals than any other nation (just one, in fact). This is a remarkable feat when you consider that the other teams competing for a spot in the finals includes France, Croatia, and Argentina. While the team has operated in a very compact manner, it is the defensive component of Morocco’s strategy which has received the highest praise in terms of its quality and resoluteness.
Much like with the formation of a successful football team, when considering portfolio construction and strategy, one’s defence (or in this case, its fixed income component) is crucial. This asset class has long been acknowledged as a core component of a balanced portfolio, providing defensive characteristics and diversification benefits to investors. The defensive characteristics of a fixed income allocation can be explained by its relative stability potential – in this case, when a bond reaches maturity, the holder can typically expect to be repaid the face value of the bond (depending on issuer creditworthiness). Naturally, this makes bonds attractive to investors seeking increased stability of capital.
A final thought on what some of the teams from this World Cup could teach us about investing is the importance of controlling one’s emotions. For example, in looking at Morocco’s impressive win over Spain in the penalty shootout, it was evident how calm the majority of Morocco’s players were in comparison to Spain, which was unable to net a single penalty. A similar picture of calm was painted again with the Croatian team which, thanks to calm and focused penalties, has managed to progress to the knockout stages for two World Cups in a row.
Similar with investing, emotions such as fear and excitement often lead investors to waiver from their designated strategy, leading to detrimental returns. Instead, a better option may be to leave emotions on the sidelines and remain invested in a well-diversified portfolio.
Scoring goals
As the World Cup can teach us, the most important factors when considering portfolio construction include diversifying one’s assets to help alleviate the impact of market shocks, while also remaining level-headed and flexible enough to recognise – and respond to – changes. Finally, and perhaps most crucially, investors should ensure their defensive allocation is not overlooked and of high enough quality to help them to achieve their overarching…goal. (Sorry – had to be done!)
For more information on these topics, you can access BetaShares’ education resources:
- An ETF Investment Portfolio Guide
- Understanding Fixed Income and Fixed Income ETFs
- Is your investing influenced by emotion?
References:
https://www.bloomberg.com/news/articles/2022-11-28/stagflation-will-dominate-in-2023-keeping-us-stocks-in-peril
https://www.afr.com/markets/commodities/commodity-boom-to-unwind-after-record-year-20220623-p5aw0u
https://www.betashares.com.au/insights/twilight-zone/
Written by
Alex Cook